You are ready to make the largest financial decision of your life by buying a home or rental property. But, you are concerned because of all the issues that people who bought in recent years have encountered. Perhaps properties are underwater, or the rental income doesn’t cover all the expenses, or mortgage payments have become unaffordable.
You are not alone if you have some of these reservations about buying a home. While those issues are just a few of the inherent risks that are present when buying real estate, there are many more. Although these issues have been around forever, only recently have typical buyers been getting better about doing their due diligence and taking the time, energy and effort to work hard to significantly lower their risk on real estate.
The process is not overly complicated, but, it is time-consuming. We’ve put together a list of categories that should be on your due diligence list. You should learn these items, tasks, procedures and how to analyze property so you can make great choices.
Here’s how to lessen the chances of something going wrong with your purchase:
1. Understand the Purchasing Process
Buyers should have a full understanding of the purchasing process from the start. Early on review the contract you will be signing, understand how to shop for the right property and know about making an offer, contingencies, appraisals, mortgage financing, and when your earnest money deposit becomes “at risk.”
2. Does This Make Financial Sense?
• Buying Investment Property – Start by penciling out the deal. You should determine the total cash you will invest and what “cash on cash” rate of return you project to earn. Bank CDs pay 1.0 percent, Bonds 5.0 percent, but real estate is riskier – so what should you earn? Five percent is suggested. Value appreciation may come down the road and certainly will help, but let’s count our cash first!
• Personal Residence Rent vs. Own – There are some simple guidelines to follow here. If you plan to own for less than five years, you should remain a renter. You are not throwing away money renting and you avoid a lot of stress. Buying for the long term is your best move. And, don’t buy just to buy something – buy the property you “love” and that will make you happy.
3. Shop Smart
Hoping to snag a once-in-a-lifetime deal on a foreclosure or short sale? If you’re trying to chase some “great” deal like at the courthouse auction, or through a distress sale, it only wastes your time and energy with little chance at success. Be prepared. These options are complex and can often fall through the cracks. Skip the get-rich-quick schemes. A more conservative approach is to shop for a traditional sale on listing websites.
4. Real Estate and Income Taxes
Buying to save money on your taxes? Most couples buying residences under $300,000 get little in net tax savings. People with higher incomes and more expensive homes get the biggest tax benefit. Surprised? Meet with your CPA to determine what, if any, tax benefits you will earn.
5. Mortgage Financing – Getting a Fair Deal
If you can get financing, it has become easier to get a “fair deal” because of new federal regulations. Regardless, you should understand your Good Faith Estimate (GFE) and how to dissect it to make sure you get that fair deal. Mortgages are for the long term, so take some time to interview a couple of lenders and understand your mortgage so you can make a good decision.
6. Homeowners Association (HOA) Condition
This is one of those items that most buyers do not even know to review. The finances and operations of an HOA are becoming a huge risk issue nowadays. If you do not understand and review them, you may get a surprise in the form of sharply higher fees or special assessments in the years to come. Meet with a knowledgeable person to help you decipher them. The goal is to avoid a community where the association is in really bad shape.
7. Home Inspection/Fix Up Costs
Having a home inspection is one of the most important things you can do as a buyer. During the inspection you should be putting together a list of what needs to be repaired and replaced. Then you can take your list to a home improvement store to get a feel for the total costs to bring the property up to the standards you desire. This should help you negotiate any seller’s credits and/or terminate the deal if the costs are too much.
8. Property and Liability Insurance
Insurance policies cover certain risks and have a maximum payout on any loss related to those risks. It is up to you to determine the maximum policy amount you want based on construction quality, cost to rebuild and your risk tolerance. The top issue – failing to increase coverage amounts over time as the cost of rebuilding increases. It is not difficult to understand and have the right coverage – we suggest getting with your agent and have a once a year checkup!
9. Title Insurance, Title Issues, and Lot Lines
This is another purchasing task that few people review. And while the risk of an issue is very low, the potential losses are huge. Taking fifteen minutes to review your title abstract/history and the plat or a survey of the parcel, then walk the property. It could save you endless headaches and financial stress down the road.
10. Other Investments
Fixer uppers, flipping, vacation rentals, second homes, apartment buildings, condohotels, land or building a home also have significant risk issues that should be evaluated carefully, before you make the decision to take on one of these investments.
By taking the time to learn the risk issues and do the proper due diligence before you buy, you can significantly reduce your risk of something going wrong. And while it’s hard work, it is much easier than straightening out a “predicament” after you close escrow.
Leonard Baron, MBA, CPA, is a San Diego State University Lecturer, a guest blogger on Zillow, the author of “Real Estate Ownership, Investment and Due Diligence 101 – A Smarter Way to Buy Real Estate”, and loves kicking the tires of a good piece of dirt! See more at ProfessorBaron.com.